This post was prompted in part by some of the questions we have received regarding IRC Sec. 280E.1 Some in the cannabis industry appear to not realize that IRC Sec. 280E applies to the industry before the retail [Dispensary] level.

We begin a series of posts relating to IRC Sec. 280E with a discussion of the application of this issue to the transportation [e.g. how an item gets from “here” to “there”] of cannabis.

The framework for our discussion is the commercial cannabis industry in California.

The three principal governmental agencies involved in the promulgation of cannabis regulations relating to transportation are: the Bureau of Cannabis Control (“BCC”); the California Department of Public Health (“”CDPH”); and the California Department of Food & Agriculture (“CDFA”).

Other California governmental agencies with a significant interest in the application of these regulations include: the California Department of Tax and Fee Administration (“CDTFA”); the California Highway Patrol (“CHP”); the Division of Occupational Safety and Health (“CAOSHA”); and State of California Economic Development Department (“EDD”).

The principal bodies of existing California law relating to transportation are found in the California Vehicle Code and the California Uniform Commercial Code.

The regulations relating to cannabis transportation conflict with existing laws and regulations as well as established commercial practices relating to transportation. In those instances in which federal or California law already addresses a particular topic, or for which there are time-honored commercial practices involving the commercial movement of commodities, California’s cannabis regulations must be interpreted and applied in a manner that does not severely conflict with already established rules of law. If the conflicts are too severe, the cannabis regulations are likely to be determined to be preempted and not enforceable.

California’s regulations relating to the transportation of commercial cannabis are founded on the utilization of a Manifest to facilitate the tracking of all commercial cannabis from source to consumer. A Manifest as the word is used in California’s cannabis regulations is specialized form of record of selected shipping information. The Manifest specified by California’s cannabis regulations is a subset of the information addressed generally in commercial shipments in a Bill of Lading. The Manifest specified in California’s cannabis regulations requires some information that would not be required by most commercial Bills of Lading. California’s cannabis regulations also specify more extensive record retention requirements than would be followed in general commercial practices. However, the Manifest specified by California’s cannabis regulations also appears to not have considered a wide-range of matters that may be addressed in Bills of Lading.

Bills of Lading are generally divided into two principal categories – negotiable and non-negotiable Bills of Lading. Notwithstanding this simple division into two categories, there are an almost infinite variety of special provisions dictated by the special requirements associated with specific materials or forms of transportation. The fundamental difference between a negotiable and a non-negotiable Bills of Lading turns on whether title to the material being transported passes on the delivery of the material to the transporter. One question which must be asked is whether the establishment of a transportation-only classification of transporter in California’s regulations considered whether such a business could utilize both negotiable and a non-negotiable Bills of Lading

We begin our analysis by defining a number of terms which are a prerequisite to understand the discussion which follows:

  • FOB Shipping Point”- is a contraction of the term “Free On-Board Shipping Point.” The term means that the buyer takes delivery of goods being shipped to it by a supplier once the goods leave the supplier’s shipping dock. Since the buyer takes ownership at the point of departure from the supplier’s shipping dock, the supplier should record a sale at that point. The Buyer assumes the risk of loss for goods from that point as well. The Buyer is responsible for the cost of shipping the goods.

  • FOB Destination” is a contraction of the term “Free On-Board Destination.” The term means that the buyer takes delivery of goods being shipped to it by a supplier once the goods arrive at the buyer’s receiving dock. The supplier records the sale when the goods are received by the buyer and bears the risk of loss while the goods are in transit. The supplier is usually responsible for the shipping cost.

  • Transport” means the physical movement of cannabis goods from one licensed premises to another licensed premises. Reg. Sec. 5000 (r)

  • Transportation Procedures2” – A description of the applicant’s procedure for transportation of cannabis goods, including whether or not the applicant will be transporting cannabis goods or contracting for transportation services. Reg. Sec. 5002 (c)(29)(A)(i)

  • Track and Trace System” – A licensee shall create and maintain an active and functional account within the track and trace system prior to engaging in any commercial cannabis activity, including the purchase, sale, test, packaging, transfer, transport, return, destruction, or disposal, of any cannabis goods. Reg. Sec. 5048(a)

  • Shipping Manifest – The document which is required to accompany any commercial cannabis shipment, with specifically enumerated information3

  • Distributor” Distributor licensees are responsible for transporting cannabis goods, arranging for testing of cannabis goods, and conducting quality assurance review of cannabis goods to ensure they comply with all the packaging and labeling requirements. Distributor transport licenses allow for the transport of cannabis goods between licensed cultivators, manufacturers, and distributors. A distributor transport licensee may not transport cannabis goods to a licensed retailer and may not engage in any other distributor activates There is a specific definition provided for a “Distributor Transport Only License4

  • Retailer” A Retailer (storefront) sells cannabis goods to customers at its premises or by delivery. A retailer must have a licensed physical location (premises) where commercial cannabis activates are conducted. A retailer (non-storefront) licensee must have a licensed premises, but it is not open to the public.

  • Manufacturer” means any involved in any aspects of the extraction process, and/or infusion process, and packaging and labeling processes, including processing, preparing, holding, and storing, packaging, or labeling of cannabis products. Manufacturing also includes any processing, preparing, holding, or storing of components and ingredients.

  • Cultivator” means anyone involved in any activity involving the planting, growing, harvesting, drying, curing, grading, or trimming of cannabis Reg. Sec. 8000(g)

Commercial cannabis originates with a Cultivator that is in simple terms, a farmer5. The expenditures made by a Cultivator in producing a cannabis crop are, in general, classified as “Cost of Goods Sold”. So long as the Cultivator refrains from engaging in other activities which bring them closer to the “line” with activities that cross over into Distribution, a Cultivator should have minimal exposure to falling within the ambit of IRC Sec. 280E. [We will revisit the topic of Cultivator’s engaging in other activities in a separate post.]

Consider two minor variations in the same simple transaction – a Cultivator sells cannabis to a Distributor or Manufacturer. The focus of this scenario is on the classification of transportation costs. In the first alternative, the Cultivator sells the cannabis to a Distributor, for a set price with shipping terms, FOB Shipping Point. The Cultivator gets paid for the cannabis and the transportation costs are paid directly by the Distributor. In the second alternative, the Cultivator ships OB Destination and pays the transportation costs. The final delivered cost of the cannabis is identical under both scenarios. Some may assert Cultivator’s payment of the transportation costs in the second alternative will cause the transportation costs to be exposed to disallowance under to IRC Sec. 280E because transportation constitutes a “trafficking” expense in many instances.


While there is no clear definition of trafficking, we do not believe IRC Sec. 280E should apply the transaction for two reasons:

  • The results in both alternatives are identical. We believe the party that pays in an otherwise identical transaction that does not otherwise change the substance of the transaction should alone cause a different result for income tax purposes.

  • More importantly, the Cultivator has not in our opinion engaged in sufficient activities constituting trafficking to appear to has crossed into the Distributor type activities which constitute trafficking, such as testing, packaging for retail sale, and labeling.

Where cannabis is transported to a Manufacturer, a similar analysis should apply. We further believe that a similar result applies to transportation costs are incurred in bringing other supplies which are used in the extraction process such as alcohol, propane, etc.

Where a Distributor operates as a Transport Only business, the distributor appears to be solely performing a service provider role. The operating costs of such a business should NOT fall within IRC Sec. 280E as such a business is merely functioning as a shipping company. We will consider the activities of a Distributor that does more than transport and deliver in a subsequent post.

1

““No deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances (within the meaning of schedule I and II of the Controlled Substances Act) which is prohibited by Federal law or the law of any State in which such trade or business is conducted.””

2 Reg. Sec. 5311 – Requirements for the Transportation of Cannabis Goods The following requirements apply when transporting cannabis goods between licensees or licensed premises:

  1. Transportation shall only be conducted by persons holding a distributor license under the Act, or employees of those persons.

(b)All vehicles transporting cannabis goods for hire shall be required to have a motor carrier permit pursuant to Chapter 2 (commencing with Section 34620) of Division 14.85 of the Vehicle Code.

(c) Transportation by means of aircraft, watercraft, drone, rail, human powered vehicle, and unmanned vehicle is prohibited.

(d) Cannabis goods shall only be transported inside of a vehicle or trailer and shall not be visible or identifiable from outside of the vehicle or trailer.

(e) Cannabis goods shall be locked in a box, container, or cage that is secured to the inside of the vehicle or trailer. For purposes of this section, the inside of the vehicle includes the trunk.

(f) While left unattended, vehicles and trailers shall be locked and secured.

(g) A distributor shall not leave a vehicle or trailer containing cannabis goods unattended in a residential area or parked overnight in a residential area.

(h) At a minimum, a distributor shall have a vehicle alarm system on all transport vehicles and trailers. Motion detectors, pressure switches, duress, panic, and hold-up alarms may also be used.

(i) Packages or containers holding cannabis goods shall not be tampered with, or opened, during transport.

(j) A distributor transporting cannabis goods shall only travel between licensees shipping or receiving cannabis goods and its own licensed premises when engaged in the transportation of cannabis goods. The distributor may transport multiple shipments of cannabis goods at once in accordance with applicable laws. A distributor shall not deviate from the travel requirements described in this section, except for necessary rest, fuel, or vehicle repair stops.

(k) Under no circumstances may non-cannabis goods, except for cannabis accessories as defined in Business and Professions Code section 26001(g), be transported with cannabis goods.

(l) Vehicles and trailers transporting cannabis goods are subject to inspection by the Bureau at any licensed premises or during transport at any time.

(m) Notwithstanding subsections (d) and (e) of this section, if it is not operationally feasible to transport cannabis goods inside of a vehicle or trailer because the licensed premises that the cannabis goods will be transported from and the licensed premises that will be receiving the cannabis goods are located within the same building or on the same parcel of land, the cannabis goods may be transported by foot, hand truck, fork lift, or other similar means. A shipping manifest that complies with this division is required when transporting cannabis goods pursuant to this subsection.

3
 § 5314. Shipping Manifest

  1. Prior to transporting cannabis goods, a distributor shall generate a shipping manifest through the track and trace system for the following activities:

(1) Testing and sampling;

(2) Sale of cannabis goods to a licensee;

(3) Destruction or disposal of cannabis goods; and

(4) Any other activity, as required pursuant to this division, or by any other licensing authority.

  1. The distributor shall transmit the shipping manifest to the Bureau and the licensee that will receive the cannabis goods prior to transporting the cannabis goods.

(c) The distributor shall ensure and verify that the cannabis goods being taken into possession for transport at the originating licensed premises are as described and accurately reflected in the shipping manifest. For purposes of this section, the distributor may verify that the cannabis goods are accurately reflected in the shipping manifest by confirming that the number of boxes of cannabis goods, type of cannabis goods, weight or units of cannabis goods matches the label on the boxes containing the cannabis goods.

(1) The distributor shall not take into possession or transport:

(A) Any cannabis goods that are not on the shipping manifest; or

(B) Any cannabis goods that are less than or greater than the amount reflected on the shipping manifest.

(2) The distributor is responsible for any discrepancies between the shipping manifest and the cannabis goods in its possession during transport, and subject to any enforcement or disciplinary action related to such discrepancy.

(3) A distributor shall not void or change a shipping manifest after departing from the originating licensed premises.

(d)A shipping manifest shall accompany every transport of cannabis goods.

(e) Notwithstanding subsection (a) of this section, if a transporting distributor has not obtained access to the track and trace system, the distributor shall complete the shipping manifest outside of the track and trace system and transmit it to the Bureau and the licensee receiving the shipment by electronic mail.

(f) If the transporting distributor has access to the track and trace system and the licensee receiving the shipment has not obtained access to the track and trace system, the distributor shall complete the shipping manifest in the track and trace system and transmit it to the Bureau. However, the distributor shall send a copy to the licensee receiving the shipment by electronic mail.

4
 5315. Distributor Transport Only License

(a) A distributor transport only licensee may transport cannabis goods between licensees; however, they shall not transport any cannabis goods except for immature plants and seeds to a retailer or to the retailer portion of a microbusiness.

(b)A complete application for a distributor transport only license shall include all the information required in an application for a Type 11-Distributor license.

  1. The licensing fee for a distributor transport only license will be based in part upon whether the licensee intends to transport only cannabis goods that the licensee has cultivated or manufactured (self-distribution), or whether the licensee intends to transport cannabis goods cultivated or manufactured by other licensees.

  1. A distributor transport only licensee shall comply with all of the requirements for a holder of a Type 11-Distributor license, except for those related to quality assurance and testing.

(e) A distributor transport only licensee shall not hold title to any cannabis goods unless the licensee also holds a state-issued cultivation, manufacturing, retailer, or microbusiness license.

(f) Holding a distributor transport only license shall not authorize a licensee to:

(1) Engage in the delivery of cannabis goods as defined in Business and Professions Code section 26001(p);

(2) Engage in the wholesale, destruction, packaging, labeling, or storing of cannabis goods; or

(3) Arrange for the testing of cannabis goods by a testing laboratory.

(g) Notwithstanding subsection (e) of this section, a distributor transport only licensee who is licensed to engage in self-distribution and whose premises will be on the same property as their licensed cultivation or manufacturing premises shall not be required to comply with the security provisions contained in Article 5 of this division.

5
 The issue of where cannabis cultivation in California is an agricultural activity which qualifies a trade or business under the Internal Revenue Code is a complex analysis in itself. See California Cannabis Cultivation – Qualification as Farming

ch